Value and taxation of NFTs

Ok. You missed out on the Beeple. Not a big deal. There are plenty of other ways you can participate in the colorful world of non-fungible tokens (NFTs). In this article, we look into the evolution of NFTs in the art world and the tax implications of trading NFTs.

NFTs can be thought of as a combination of a computer file and a certificate of ownership. Non-fungible tokens are distinctly identifiable, unique, not imitable, and not interchangeable with each other. In contrast, fungible tokens such as Bitcoin or Ethereum, are all alike and interchangeable. NFTs are therefore particularly suitable for proving the origin of digital art. In order to create an NFT, it is uploaded to an appropriate platform, signed, minted and, if it is up for sale, the conditions are set for the transaction. NFTs can be images, GIFs, files or audio and video recordings.

So much for the practical process in case you plan to make your own NFTs. The question remains how the value and price of digital art is determined.

Understanding the value of collectibles or art objects as a non-collector is often not so easy. The commodity value of a baseball trading card of about USD 0.50 has nothing to do with the possible sales price running in the millions. Whether the value of a Picasso lies in the artistic value of the painting or in the subjectively perceived beauty in the eye of the beholder is irrelevant for the price. If someone is willing to pay for it, what is considered valuable gets a price. And this is what digital art got in 2021.

An argument that is often brought forward against digital art is that nothing exists that can be physically touched.

True, and sometimes there’s not even anything visible online anymore. As far as NFTs are concerned, you have to distinguish between the image being visible online and the certificate of ownership. When you buy an NFT, you’re not buying a piece of art or an image file. Rather you are minting a new cryptographic signature that, when decoded, points to an image stored elsewhere on the network. If a platform from which you bought the image decides to no longer display it, it will no longer be visible there. If the image is removed from the source, it is no longer visible at all. Neither for you and nor for anyone else.

What is visible on the irrevocable record of the blockchain is the confirmation of ownership. Or may be not. Stored yes, visible possibly not. In a rapidly expanding universe players sometimes like to experiment with new token formats. For example, the multitoken format ERC-1155 from OpenSea is not yet compatible with Etherscan and therefore not visible. For the sake of simplicity, let’s assume that the purchased image is visible on the web in a form that is appealing to the human eye and that the minted entry is traceable on the blockchain.

Value due to status and the story behind a piece of art
The Beeple artwork Everydays consists of 5000 individual works that show the development of the artist in his art form over 5000 days. Thus, it has already achieved a unique status as the first of its kind. Metapurse has acquired this piece of art. The Singapore-based investor group, which is experimenting with digital art and collective ownership through tokenization, has secured a unique asset and potentially a significant catalyst for change in the art scene. It’s a great story, with a fair value of USD 69 million in the spring of 2021.

Cryptopunks represent another fascinating phenomenon in the NFT market. They are limited to 10,000 pieces and were initially given away for free.

Enthusiasts love the uniqueness of ‘their’ Cryptopunk and use them as avatars on social media, among other things. As an outsider, the uniqueness of the different pixelated figures, the artistic value and the associated price are not readily apparent. What, for example, causes the significant difference in the price of Cryptopunk #8348, that generated a price offer of $1 million, and Cryptopunk #8347, for which the last offer was $15 in 2017?

Status and Usage
NFTs make the value of status visible and give it a price. Cryptopunk #8348 is owned by a well-known crypto trader. The owner of Punk #8347 is unknown in social media. Jack Dorsey’s (the founder of Twitter) first tweet is estimated to be an NFT in the millions. My first tweet? — Oh well. We’ll see.

Value transfer in social media
In recent years, digital art has contributed greatly to generating traffic on social media platforms. The currency of the platforms are views and likes. Without having thrown off any significant monetary value to the artists themselves.

NFTs can be set up so that the original artists share in any further sales. This development has the potential to have a disruptive effect on the current social media landscape.

Are we currently witness to a fascinating shift in our collective assessment of value, or are NFTs becoming a bubble in which enterprising crypto investors and those who aspire to become them are raking in sharp increases in wealth? Either way, trading NFTs transfers wealth into the pockets of digital artists who have historically received notoriously little value for their time and creations.

New technologies are wonderfully imperfect. Of course, once again, not everyone who wants to, will have access to the new technology, and NFTs in and of themselves will do nothing to change this injustice. Generating NFTs requires electricity, which is by no means all green. Work and money will be lost and existing works of art will be stolen, copied and sold as NFTs. Technology cannot change these inadequacies.

Whether NFTs catapult the crypto community’s long-awaited main stream use case for blockchain technology to the moon, whether they enable artists to make a fair living from their art even without a day job, or whether they become a bubble in which many people will lose money and a few will make a lot of money depends on what we all make of it.

Here at Blockpit we made a tax software for you, that simplifies your life in the cryptospace.

From a tax perspective, an NFT purchase or sale is a token exchange. In the US the gain from a private sale is taxable as individual income tax and as capital gains tax after a one-year holding period. The taxable value for the new, unique NFT token can be determined by the equivalent value in crypto assets at the current market rate. As usual, when new ecosystems emerge, there is a disconnect between what is possible in the new system and how to manage the administrative implications. The responsibility lies with the users themselves to pay the appropriate taxes. Since NFT trading typically involves large amounts of money and the art market has historically been popular for creatively avoiding taxes by exploiting gray areas, interest in NFTs from the relevant authorities will almost certainly not be long in coming.

We recommend complete documentation of all purchases and sales. If a complete record is not available, authorities will assume the least favorable scenario for taxpayers.

The Blockpit software was developed several years ago out of our own trading experience and the necessity to pay taxes correctly in a complex system that is still poorly understood by traditional institutions. It is our deep desire to provide you with the highest possible legal certainty for your crypto trading through continuous development and through our cooperation with the best tax experts.

To stay up to date in this dynamic system, sign up for the Blockpit newsletter.

Disclaimer: The information provided in this blog post is for general information purposes only. The information was completed to the best of our knowledge and does not claim either correctness or accuracy. For detailed information on crypto regulations, we recommend contacting a certified legal advisor in the respective country. If any questions occur, feel free to contact us on our social media channels.

Originally published at https://blog.blockpit.io on May 2, 2021.